The Activist Investor: Microsoft/Yahoo! Deal Would Be Perfect

I've been involved in an activist campaign aimed at increasing shareholder value at Yahoo!YHOO for the last 15 months. When I started, I hoped that some swift action on the part of Yahoo!'s management and board would help the Internet pioneer make better use of its brand and traffic to deliver superior returns for its shareholders.

However, it took Microsoft'sMSFT 62% premium offer, not the bold moves of Yahoo!, to finally unlock that value. (From Jan. 5, 2007, when I launched my activism, to the day Microsoft announced its bid, Yahoo! delivered a +11.27% return vs. -4.59% for the S&P.)

The deal on the table from Microsoft is a good one for Yahoo! shareholders (although we'd like better). It's certainly better than the prospect of an independent Yahoo! or a shotgun marriage with Time Warner'sTWX AOL or News Corp's.NWS MySpace. That's a recipe for a quick return to a sub-$20 stock price.

Yahoo!'s stock price would likely sink a lot more than that if Microsoft walked away from its offer (as some rumors Friday suggested it might). From Feb. 1 to April 4, Google'sGOOG stock is down over 16%. If Microsoft's deal had never come to pass, Yahoo!'s stock would likely have gone down just as much, if not more, meaning it would be around $16. There appears to be consensus among the other Yahoo! shareholders I've spoken with that $31 a share is better than $16.

Most press coverage of this takeover drama has failed to observe that this is also a very good deal for Microsoft and its shareholders -- and it still would be, even if they upped the price a few more dollars (still a likely possibility, despite Steve Ballmer's letter over the weekend that he was going to launch a proxy fight in three weeks if there was continued silence from Sunnyvale).

Several Microsoft shareholders have groused about buying Yahoo! They worry that the price is too high, it forces Microsoft to issue debt, it uses up its cash, and the integration risks are plentiful. One analyst chuckled after the deal was announced that Google co-founders "Sergey and Larry are going to have no problems sleeping" thinking about the combination of Yahoo! and Microsoft.

Microsoft actually was the target of shareholder discontent in 2006. It never coalesced into an organized activist effort, but many -- like Joe Rosenberg, Chief Investment Officer of Loews Corporation, voiced complaints. There was $35 billion in cash sitting on the balance sheet, with another $10 billion in invested securities. The stock had gone sideways since 1998 and Xbox seemed like a sinkhole.

However, from May 2006 until just prior to the Yahoo! deal being announced, Microsoft was up 35% vs. about 2% for the S&P. It's still 15 points ahead of the S&P, even after the pull-back in the last two months relating to worries about the Yahoo! deal.

Microsoft has operated well in the last two years. It also upped its dividend, delivered Windows Vista, and nobody has used the word "sinkhole" since hearing about a game called "Halo 3" for the Xbox.

But Rosenberg's still not happy, at least not with Ballmer or this deal for Yahoo! He said recently, "It's a bad reflection on Ballmer that he's willing to pay a ridiculous price for Yahoo! Microsoft is not going to earn anything like a reasonable rate of return on its investment in Yahoo! It just doesn't make sense." He went on to ask, "Can you think of a major tech deal that ever worked out?"

Of course there have been major tech deals that have achieved greater scale, with cost savings. There's no reason that the technology industry can't consolidate, with the acquirer getting more customers at lower costs like any other industry, as Larry Ellison has shown for the last five years at OracleORCL.